Open Text Corporation (OTEX) Earnings Call Transcript & Summary

Thank you for standing by. This is the conference operator. Welcome to the OpenText Corporation Conference Call. [Operator Instructions] And the conference is being recorded. [Operator Instructions] I would now like to turn the conference over to Harry Blount, Senior Vice President, Investor Relations. Please go ahead.

Good afternoon, everyone. With me on the call today are OpenText's Chief Executive Officer and Chief Technology Officer, Mark J. Barrenechea; and our Executive Vice President and Chief Financial Officer, Madhu Ranganathan. We have some prepared remarks followed by a question-and-answer session. Today's call will last approximately 45 minutes and is being recorded with a replay available shortly thereafter. I'd like to take a moment and direct investors to the Investor Relations section of our website, investors.opentext.com, where we posted a link to the offer landing page, which consists of additional information related to the offer, including our investor presentation and replay of today's call. And now I'll proceed with the reading of our safe harbor statement. Please note that during the course of this conference call, we may make statements relating to the offer, the proposed acquisition and the future performance of OpenText that contain forward-looking information. While these forward-looking statements represent our current expectations and projections, actual results could differ materially from a conclusion, forecast or projection in the forward-looking statements made today. Certain material factors and assumptions were applied in drawing any such statement. Additional information about the material factors that could cause actual results to differ materially from a conclusion, forecast or projection in the forward-looking information as well as risk factors that may impact future performance results of OpenText are contained in OpenText's recent forms 10-K and 10-Q as well as in our press release that was distributed earlier today, which may be found on our website. We undertake no obligation to update these forward-looking statements unless required to do so by law. In addition, our conference call may include discussions of certain non-GAAP financial measures, reconciliations of any of our non-GAAP financial measures to their most directly comparable GAAP measures may be found within our public filings and other materials, which are available on our website. Reconciliations of Microsoft -- Micro Focus' non-GAAP financial measures to their most directly comparable IFRS measures may be found within the Micro Focus public filings and other materials that are available on its website as referenced in the investor materials. And with that, I will hand the call over to Mark.

Thank you, Harry, and welcome, everyone, to today's call. It's great to be in our Richmond Hill office. Before I get into the details of our intention to acquire Micro Focus, I want to start with our industrial thesis and why today is a really important moment in our 32-year young history as we build an even stronger future for our company. The world is increasingly getting more complex, and there is an urgent imperative to accelerate digital transformations. The complexity is obvious and ubiquitous, supply chains, cybersecurity, trust, inflation, talent and labor challenges, the ongoing pandemic, geopolitical unrest and climate issues all around us. And the imperative is crystal clear. IDC reports over $6 trillion in business investment for digital technologies and transformations through 2024. McKinsey reports over $1 trillion in business value to be unlocked through cloud adoption. Gartner, citing 75% of executives are held back from their IT transformation plans due to labor shortages and IDC notes a staggering 11 stakeholders involved to approve a technology buying decision inclining. Digital transformation is the largest technology opportunity in the history of our industry. It entails extreme automation and the digitalization of all business, operating in the cloud, running at global scale, eliminating friction from processes, the modernization of applications, accelerated time to value and doing this with trust and doing this responsibly. Customers need to gain the information advantage as we like to say, not just a process advantage. Let's be frank. This end-to-end digitalization of all corporate operations is the only answer. And customers are looking for companies with proven reputations of innovation, delivered outcomes, trust, global abilities and staying power. They are looking for companies like OpenText. There has to be a better way to achieve digital transformation, and we believe OpenText has a big role to play and being the market leader in information management solutions for our customers and partners. With today's announcement, information management just got a lot bigger. And OpenText is rated a step-up to this opportunity on all fronts. This transaction will create one of the largest global cloud and software companies in the world. The expertise, financial strength and scale of the combined business will accelerate our existing plans in product development, cloud transition, Global 10,000 coverage and improvement of our business. Customers will also have access to an enhanced broad product portfolio and will accelerate their digital transformation agendas and give them greater flexibility and choice. For employees, it means being part of a market-leading cloud and software business, committed to innovation with the prospect of benefiting from new opportunities within the enlarged group. And for Micro Focus shareholders, certainty and the opportunity to crystallize in cash, the value of their investments today at a significant premium; and for OpenText shareholders, future value creation on a combined revenue scale, cloud revenue acceleration, upper quartile EBITDA dollars and upper quartile free cash flow growth. Some facts about Micro Focus, $2.7 billion of trailing 12-month revenues for period ending April 22, $942 million of adjusted EBITDA or 35.3% on a same TTM basis, a market leader in digital management as reported by Forrester and Gartner and IDC. Marquee enterprise customers and Global 10,000 across all major industries, 11,000 employees, headquartered in Newbury, U.K. near the OpenText Center of Excellence in Reading, U.K. Strong ARR of 69% plus and are focused in high-value information areas across a wide selection of buyers. Information management governance, information data protection and cyber resilience, information technology and service operations and management, application modernization, connectivity and delivery and information analytics with Vertica. Here are some of the terms of the acquisition and the numbers are approximate. $6 billion acquisition price inclusive of Micro Focus's cash and debt. On a multiple basis, that's 2.2x revenue and 6.3x adjusted EBITDA, is an all-cash consideration to be funded by $4.6 billion in new debt, $1.3 billion in cash and a $600 million draw on our existing revolver credit facility. We do not intend to use equity. We're targeting Micro Focus to be on the OpenText operating model within 6 quarters of closing, and we expect to close the transition in the first quarter of calendar '23, subject to the satisfaction or where applicable waiver of the conditions set out in Appendix 1 to the announcement. We know the Micro Focus business well. We've observed it for many years. Under Stephen Murdoch's leadership and the leadership team, the business is on a stronger path, with line of sight to stabilization. They've done a great job. And with stabilization in view, we believe we can help accelerate this and then return the business to grow faster. We believe it's the right time. OpenText is executing well. Our cloud has scaled. We have gained amazing experience in digital transformation and delivered strong results through transformative acquisitions such as GXS, Documentum and Carbonite, and we're in a strong financial position. This is the right company and right opportunity with amazing products, strong talent, marquee customers and valued intellectual property in a business that can gain value from the OpenText business system and accelerating their plans in the following areas: the cloud, both public, private and API with our know-how and platform. We're reaching their full potential and customer support and maintenance practices and results, reaching their full potential in go-to-market and access to an SMB channel and stronger partnerships with market leaders, even stronger operating results across many areas, including gross margin, EBITDA and EBITDA to cash flow conversion. The combined business would be enhancing our leadership across the TAM of $170 billion, focused on strategic information management domains and significantly broadcasting -- excuse me, broadening our touch points and buyer groups. On Slide 7 and 10 of our investor deck, you will see deeper insights into the functional domains from content to security to applications and deeper insights in the expanded buyer groups from supply chain to business operations to tech operations. Let's look at the combined business. 25,000 employees and experts strong, $6.2 billion in total revenues. Line of sight to $400 million of cost synergies, upper quartile adjusted EBITDA dollars of $2.2 billion and expanding. OpenText adjusted EBITDA dollars in F '22 were $1.3 billion; for Micro Focus, trailing 12 months, $942 million. Upper quartile free cash flows and expanding. OpenText free cash flows in '22 were $889 million and Micro Focus trailing 12 months, $292 million. We're maintaining our F '25 aspirations of adjusted EBITDA margins for the combined group between 37% to 39% and the transaction would be immediately accretive to adjusted EBITDA and adjusted EPS. With the OpenText Business System, identified cost synergies and upper quartile margins, this is a powerful cash generation company and the class of the best run technology companies in the world. Let me spend a moment on 3 of the larger opportunity areas: cloud renewals and innovation acceleration on the cloud. OpenText is operating very well and growing. Over the last several years, we have uplifted over 3,000 customers from off cloud to private cloud, introduced our public cloud and created a developer API cloud. We posted double-digit cloud bookings in fiscal '22. And as we mentioned on our earnings call just a few weeks ago, we expect to continue to generate enterprise cloud bookings growth of 15% or better through fiscal '25. Our cloud and professional services teams are delivering strong results, and we believe these same processes and expertise can be applied to uplift Micro Focus' customers to the cloud as well. Renewals. Over the last few years, OpenText has transformed its maintenance business to a customer support business with many value-added offerings and services, including security, premium and extended support. We see a very similar opportunity to add enhancements to Micro Focus maintenance business. And then the third area I want to talk about is innovation acceleration. Over the last few years, OpenText has brought its products into the cloud, and we announced Titanium, the next evolution of the OpenText Cloud to expand capabilities and further reduce friction for customers. We see an opportunity to continue the journey Micro Focus has been on to bring all of their high-value products to the cloud and leverage Titanium. Before I turn the call over to Madhu, let me speak to the key commitments we are making to our shareholders upon closing. Return Micro Focus to organic total growth, uplift Micro Focus customers to the cloud and accelerate organic cloud growth, improve the renewals business, leverage our proven OpenText business system to drive an accretive integration, upper quartile adjusted EBITDA and adjusted EBITDA expansion, and we're maintaining our F '25 aspirations of adjusted EBITDA margins between 37% to 39%. Upper quartile free cash flows and free cash flow expansion. We rapidly delevered with GXS, Documentum and Carbonite, and we have a well chronicled and proven track record. We plan on getting below 3x leverage in 8 quarters after close and will provide you with quarterly visibility and tracking. Our dividend program to continue, a transparent integration framework with quarterly visibility and tracking. And we'll use this opportunity to provide enhanced visibility into our value business areas, learning from the best technology companies. We'll provide a financial model and projections after we close. At the appropriate point in time, I look forward to welcoming the amazing Micro Focus employees, partners and customers to OpenText. I want to take a moment to acknowledge and thank the Micro Focus Board and leadership. Greg Lock, their Chair; Stephen Murdoch, their CEO; and Matt Ashley, their CFO; and the rest of Micro Focus' management team and employees for their incredible efforts towards the transformation of their business, and we look forward to the partnership ahead. It's the one that brings peace for all. And with that, let me turn the call over to Madhu. Madhu?

Thank you, Mark, and thank you all for joining us today. During our last earnings call in early August, we presented to you the OpenText Fiscal 2023 Total Growth Strategy Model and fiscal 2025 aspirations. As I recall, our fiscal 2023 total growth strategy included Enterprise Cloud bookings growth of 15% plus and total cloud revenues up 6% to 8% in constant currency. Our fiscal 2025 aspiration, specifically, enterprise cloud bookings of 15% plus, organic revenue growth of 2% to 4%, led by cloud organic growth of 6% to 8%. ARR, annual recurring revenue of 85% of total revenues. Adjusted EBITDA margin of 37% to 39% and free cash flows of $1.1 billion plus. Today's announcement does not change our core plan. We remain confident of the strength of our targets, our aspirations and execution framework. As we speak about the Micro Focus announcement, incredible efforts to date by the Micro Focus team towards strengthening and transforming the business is appreciated by OpenText, and we look forward to our partnership ahead. Now let me walk through the financial highlights and opportunities relating to Micro Focus. Our press release and investor presentation references pro forma financial information -- and provided to us by Micro Focus, which is unaudited. This pro forma information represents Micro Focus' results for the trailing 12-month period ended April 30, 2022, and excludes the results of Digital Safe, which was divested by Micro Focus during this period. We will provide the complete financial outlook and related disclosures upon closing of the transaction, which we expect in the first calendar quarter of 2023. Mark shared in his prepared remarks, transaction highlights and our financing structures. Our source of financing assumes that we do not have full operational use of Micro Focus cash at closing, primarily due to timing and also includes fees and transaction-related costs. We have received strong support and commitments on our financing, and we do not contemplate raising any equity to fund the acquisition. And let me talk about revenue. Micro Focus reported $2.9 billion for the fiscal year ended October 31, 2021. And today, we are providing from Micro Focus trailing 12-month ended April 30, 2022, of $2.7 billion. As Mark outlined in his remarks, we expect to accelerate stabilization and return Micro Focus to total revenue organic growth. On adjusted EBITDA, Micro Focus' strong adjusted EBITDA at 35.3% for the trailing 12 months ended April 30, 2022. With the application of the OpenText Business System, upon closing, and effective integration, we believe will result in EBITDA expansion. We expect to have micro focus on our operating model over 6 quarters. Cost synergies. Cost synergies shared today are expected to be realized over an 8 quarter time frame post close. We acknowledge Micro Focus' previously announced cost reduction program of approximately $300 million net of inflation with several measures already underway. We expect to work with the leadership to bring the program to its full completion. In addition, we have identified $100 million of additional cost synergies as Micro Focus rolls under the OpenText umbrella, addressing duplicative public company and facilities cost systems and processes. We have a great opportunity to bring a high level of operational excellence. On free cash flows, on a pro forma basis, Micro Focus' adjusted free cash flow was 9.5% of revenues during the trailing 12 months ended April 30, 2022. Over the period of 8 quarters post close, we expect to expand Micro Focus' free cash flows and maintain in the low to mid-20s as a percentage of revenue. The current conversion for Micro Focus from adjusted EBITDA to free cash flow is approximately 30%. Applying OpenText's experience to enhance Micro Focus' working capital engine will be a key priority and resulting in a higher conversion ratio of adjusted EBITDA to free cash flows. OpenText's long-term aspirations on a stand-alone basis, as shared with all of you at our March Investor Day, noted $6 billion-plus cumulative free cash flows over the next several years, getting Micro Focus to our operating model and free cash flow conversion standards gives us an opportunity to increase the $6 billion-plus aspiration significantly. We will provide a full update upon close. And moving to deleverage. With expanding EBITDA and free cash flows being a priority, we look to delever to a net leverage ratio of less than 3x within 8 quarters following close. This has been a proven run of play for OpenText as we acquire a company, secure debt and delever rapidly. We will keep you updated along the way. On integration, I would point you to Slide 21 of our investor deck, where we have outlined our detailed integration execution framework for Micro Focus. OpenText has deep expertise, a long history of making acquisitions and delivering strong cash-based returns, including complex integrations. With respect to Micro Focus, we will apply our experience along with the added strategy and resources to align Micro Focus' global scale of people, products and customers. On our disclosures, during the last earnings call, we expanded our disclosures to provide financial outlook relating to enterprise cloud bookings. With Micro Focus, we are ready to uplift our commitment to provide clear and enhanced visibility into our high-value businesses with expanded portfolio of products and business units, taking lessons from the best technology companies. Lastly, I want to reiterate our commitments as Mark shared in his remarks. There are 8 commitments relating to the transaction outlined on Slide 24 of the investor presentation. We are excited to deliver to those commitments. With that, a big thank you to the OpenText and Magnum teams for all their hard work and support and look forward to driving all efforts towards closing the transaction. And let me open up the call to questions.

[Operator Instructions] Our first question is from Steven Li with Raymond James.

I wanted to see if you can reconcile for me, so Micro Focus' EBITDA currently is at 35%, like you said, Madhu, [indiscernible] first half results, that has about [ $150 ] million of cost savings in there. So that leaves $250 million synergies to come, which is about 10 points of margin. So I wanted to ask why Micro Focus would just be on OpenText operating model in 6 quarters. Should we not be looking at 42% plus margins with the synergies?

Yes. Yes. Steven, thank you for the question. So there are a few parts to it. One, as you heard in the call, we are looking to stabilize and accelerate revenues and that will require investments. We are absolutely going to pursue the cost reduction as we mentioned. So you sort of look at growing revenue by stabilizing, taking a look at, as Mark said, the high value in a business areas as well as implementing the remainder of the cost reduction, getting it to a full program. We're just giving ourselves 6 quarters to put all of that together. And Mark, do you want to add any comments here?

Yes. And Steven, we're not here to provide a financial model, a set of projections yet. We'll do that upon closing. Clearly, there is opportunity on the EBITDA side, converting that EBITDA to free cash flow. And we're going to invest to stabilize and grow and accelerate cloud. So we're providing a lot of information today. We'll provide our financial models and targets upon close. We are confirming today OpenText target models for this year and holding on to very clearly to our aspirations for F '27 of 37% to 39% with opportunity. So more to come when we close.

Okay. Great. And Mark, on the revenues, why are we losing revenues, Micro Focus?

I'm sorry, I haven't done a call in my office [indiscernible] I forgot to unplug the phone. So sorry, sorry, we're all here in Richmond Hill. Sorry about that. Look, I think they're going to benefit significantly. And the first piece is we've transformed our renewals business, as we've talked about, to a larger business of other services that, of course, we have our license maintenance piece in there. But we have customer success pieces, we have security pieces, assessment services. We run a world-class renewals practice. As you saw at the end of the year, we reported 94% renewals. That -- those learnings, they'll benefit from. As well, we'll be able to accelerate there -- we'll be able to find technologies and accelerate their transformation to private, public and in an API cloud. And our proven OpenText business system will just make the entire group even more efficient. So cloud technologies and renewals, Steven, are the 2 big areas that we're shouting out.

Got it. And then the return to organic growth, best guess at the time line for that organic growth return, Mark, for Micro Focus?

Yes. I'm not ready to say that. When we close, we'll talk more -- we'll talk specifically about the financial model and the business plan.

The next question is from Thanos Moschopoulos with BMO Capital Markets.

I don't know if you can comment on this. But in terms of the deferred revenue write-down, should that be comparable to what you've seen in the prior acquisitions?

Yes, sorry, Thanos, your question was about deferred revenue?

Yes, the deferred revenue write-down, whether that would be consistent with what we've seen in your prior acquisitions.

I'm going to maybe alter your question in a way. If you're referring to the purchase price adjustments, we did have a new accounting regulation. I think we're talking about a year ago where we no longer have to do the PPA write-down. So we are on the new accounting standards as far as PPA goes.

Okay. That's helpful. In general, can you comment on whether there's any other accounting nuances we should be aware of when we're looking at Micro Focus's revenue recognition and financials in relation to how you'll be supporting them?

Yes, I'll answer it in 2 parts. As I mentioned, we shared today the pro forma financials for April as Micro Focus provided to us. And second, they have the public information out there. I will say, being a software provider, a software company from a revenue recognition perspective, it is pretty consistent with what we've seen in the past. And also keep in mind, I mean I'm sorry, if you don't mind, just one more. Just keep in mind that we have a couple of steps to go. They are IFRS and we have to bring them to our sort of non-GAAP and to the U.S. GAAP, and we'll work on all of those at the time of the close.

And then finally, Mark, just going back to the revenue question. I mean just clearly, some declining assets [ consensus estimates call for ] ongoing declines in future years. So it's a message from you that a lot of it is really around blocking and tackling, leveraging the best practices. I mean is there anything more fundamental that might need to be fixed or it could be a challenge? Or is it just blocking and tackling from your perspective?

Yes. Let me just kind of amplify a little bit, and thank you for that, Thanos. The fundamentals look a lot like Documentum to me, but only with more scale. When we purchased Documentum, it was slightly declining. We stabilized it, and now it's growing well in the cloud. And Micro Focus has been on a path under Stephen's leadership doing a really nice job to stabilization. And I'd point you to some of their public comments on where they feel they're going to stabilize. And OpenText can help accelerate that. There are a handful of areas. You'll note -- I've taken a note here, let me see if I can find it quickly. Number one is renewals. If you look at their first half results that they posted in April, the significant decline was in renewals. We can clearly help there -- clearly help with our best practices. Second piece is accelerating to the cloud. They're just starting their journey. We have a great slide in our investor deck showing our movement to -- yes, Slide 13, -- thank you, Madhu, where fiscal '13 to our fiscal '22, we're -- we've gone from $180 million of cloud revenues to $1.5 billion. And they look like where they were on our journey many years ago at $136 million and only 5% of revenues. So private cloud is difficult technology and expertise, and we've scaled. That's going to be directly applicable to them. Acceleration in some technologies on public cloud in SaaS. So renewals of best practices, technologies and cloud access to an SMB channel. And those things together give us the confidence to accelerate their stabilization and return them to total organic growth and faster acceleration of cloud growth.

[Operator Instructions] Our next question is from Paul Treiber with RBC Capital Markets.

Just say, Micro Focus, you've made a number of acquisitions over its history. Just in regards to the integration of the underlying business, how much work do you feel you have in integrating the acquisitions in the businesses underneath Micro Focus as opposed to just integrating Micro Focus with OpenText?

Yes, Paul, thanks for the question. Look, they haven't done large acquisitions recently. So you look at there are 6 areas, their information management and governance area. The big pieces there we're quite excited about are idle and secure content management, not much integration from our view, that needs to go on there. On the ITOM side or the IT operations management, they haven't done an acquisition there recently, but they have OpsBridge, their network management, data center automation and service management. And they have a new SaaS product there called service management automation cloud or SMAC. On the cyber resiliency side, Fortify, ArcSight, Voltage, NetIQ, haven't done a recent acquisition there. They have a new integrated SaaS offering. On the application modernization and connectivity, which is the distributed COBOL hosted connectivity, not a recent acquisition. And we're quite excited about Vertica, as a stand-alone analytics. So I would say, they're quite long -- far along that we can see of what they've integrated, right? Now we see opportunities into our portfolio, bringing some of our public SaaS closer to service management. They're bringing advanced analytics across our portfolio, et cetera. So -- no, I think they're fairly well integrated and the future integration is all on the cloud pieces for them.